Thursday, July 30, 2009

Leveraged Loan Index Getting Frothy

Here is an interesting chart showing how much leveraged loans have bounced back from their December lows. Two points are worth noting:
1. Bank loans have nearly bounced back to their pre-Lehman levels and now trade close to 90 cents of par. While fund flows could continue to tighten spreads (and certainly have over the last few weeks), much of the easy money, and the absolute/generational no brainer money of Nov/Dec 2008, has been sucked dry.
2. Loans bottomed well before stocks made their March 9th low. In fact, despite the modest bounce in Jan/Feb, as credit-related hedge funds prepared for March 31 redemptions, the leveraged loan market has been on a steady trajectory upward.

I find it pretty amazing how in the absence of any real fundamental improvement in the economy investor psychology has swung so dramatically in the last 3 months. We’ll see over the coming months/quarters whether such enthusiasm actually makes its way into the real economy.

Thursday, July 23, 2009

Home Prices Continuing Their Ascent in California

Southern California home prices continued their steady ascent in June, rising by 6.4% over the prior month. Home prices rose in each of the six regions reported by DQ News, with Los Angeles and San Diego showing the most pronounced sequential increases. While some industry analysts have rightly pointed out that mix may be driving the sequential increases as higher end homes enter the foreclosure process (particularly many financed with Alt-A loans and pay-option ARMs), I think this argument ultimately misses the point. Whether April 2009 represented the bottom or we have another 5-10% to go (certainly quite possible, particularly as unemployment picks up), the data clearly shows that the home price contraction in Southern California is nearing an end. New supply has come to a screeching halt, affordability is off the charts, and the rent vs. buy equation is clearly in favor of the latter for most parts of California. Further, the $8,000 federal stimulus and the $10,000 state-specific tax credit are making homeownership an incredibly attractive option for first time buyers in what was once considered the most troubled housing market in the country.

Friday, July 17, 2009

Another Bubble Forming in China

China’s massive 4 trillion yuan stimulus package appears to be successfully fomenting another credit and stock market bubble in the country. Chinese banks are estimated to have lent 7.3 trillion renminbi (~$1 trillion) in the first half of 2009 alone, compared to Rmb4.9 trillion in all of 2008, Rmb3.6 trillion in 2007, and Rmb 3.2 trillion in 2006. At the end of June, loans outstanding were 34.4% higher than a year ago and M2 grew by 28.5% year-to-date; two clear signs of an overheated market.

Providing further evidence of a forming bubble, the Shanghai A-share market has jumped by ~70% year-to-date. Further, individual investors have seemingly forgotten the stock market meltdown last year, opening more than 1.6 million stock trading accounts in June – 68% more than the year before (and certainly a good sign of the speculative juices forming in the country). While the headline GDP growth number of 7.9% confirms a clear rebound in the economy, investors ought to be concerned with the massive growth in bank lending – much of it directed by government officials. Further, the uses of this newfound liquidity should raise a significant red flag to discerning investors - some economists suggest that as much as 15% or $145 billion has been diverted into speculation and real estate.

Unfortunately, it is exceedingly difficult to call the top of a speculative bubble and I suspect that we are only seeing the beginning of what is to come in China. With over $2.13 trillion of government reserves and banks acting as agents for the state, the Chinese stock market could continue to be buoyed by an easy lending environment. Chinese officials have yet to raise interest rates or increase reserve requirements; actions which popped the previous bubble. In the absence of these actions, which presumably would curtail bank lending, I would refrain from shorting the Chinese market. Like investors who thought the Nasdaq was “irrationally exuberant” in 1996, only when lending begins to decline and liquidity is drained from the system, is it safe to short an overheated market. Just as an inability of CLECs to refinance their bloated capital structures served as the peak in the tech/telecom bubble, so will bankruptcies in China’s most speculative companies provide the all clear sign to short the market. Though until that point, which could remain years away, I would patiently observe from the sidelines.

Over the coming months/quarters (and potentially years!), I’ll be on the lookout for the proverbial canaries in the coal mine.

Thursday, July 16, 2009

Initial Jobless Claims - Leading Indicator for Recovery in Q3?

As suggested in the chart above, initial jobless claims have fallen by over 150,000 since peaking at 674,000 for the week ending March 27, 2009. While new jobless claims of over 500,000 hardly reflects a robust economy, a peaking of jobless claims has generally preceded the official end of a recession by 2-6 months (see data on the last seven recessions under the chart).

The steep drop in this figure over just the last three weeks (105,000 reduction in claims) provides compelling evidence that the worst of the recession may be behind us. While Q3 may very well show GDP growth, particularly with a narrowing of the trade gap, the economy still remains highly fragile and dependent on unprecedented government involvement. Though I have no particular insights into what 2010 brings (much less tomorrow!), i would posit that we could see a double dip recession by the first half of next year as the Fed’s liquidity programs roll off and the nation’s banks are compelled to stand on their own.

Wednesday, July 15, 2009

Manufacturing Capacity Utilization Breaches New Lows

Manufacturing capacity utilization breached a new post-WWII low, declining to 64.6% in June. As indicated in the chart above, the June results are off the charts when benchmarked against prior recessions in the US (note the prior low was in the severe recession of the early 80s when capacity utilization troughed at 68.6%). While unprecedented money printing by the Fed supports the long-term inflationist view, the massive slack that exists in the economy, suggests that deflation remains the most pressing issue over the near-term. Talk to any homebuilder, retailer, or mall owner for confirmation of the lack of pricing power that exists for a broad swath of US companies.

An interesting takeaway from the chart, which lends some credence to the argument put forth by the inflation bulls, is how sharply capacity utilization ramps up exiting each of the post-WWII recessions. While avoiding a Japanese-style debt deflation is critically important, the Fed must be very careful to ease up the breaks once the economy begins to heal. Should the economy follow the trajectory of prior recessions, a combination of the supply destruction going on in most industries coupled with the massive monetary stimulus provided in the Fed, could stoke an inflationary spiral that puts the 1970s commodity bubble to shame.

Friday, July 10, 2009

Natural Gas Rig Count

The natural gas rig count continues to crater, falling by another 16 units to 672 total rigs. Since peaking in September 2008 at over 1600, the number of natural gas rigs in operation has fallen by nearly 60%. While prices remain under severe pressure due to excess supply and lackluster demand, the rapid falloff in rig count suggests a major bull market is in the works. Further, current spot prices ($3.50 BTU) remain well below the marginal cost of production for most fields (generally around $6-$7), almost guaranteeing that prices will have to rise to coax new supply onto the market. Finally, current spot prices incorporate almost no risk premium for seasonal hurricanes and/or legislation that will likely favor natural gas in Obama’s impending energy bill.

The cure for low prices is lows prices and nowhere is that more evident than in the natural gas market.